7.8 Direct Rollover or Personal Rollover
If you are an employee or a self-employed person entitled to an eligible rollover distribution (7.7) from a qualified plan, you may choose a direct rollover, or if you actually receive the distribution you may make a personal rollover. To avoid withholding, choose a direct rollover. You must receive a written explanation of your rollover rights from your plan administrator before an eligible rollover distribution is made.
Rollover to Roth IRA.
An eligible rollover distribution from a qualified employer plan, 403(b) plan, or governmental 457 plan may be rolled over to a Roth IRA, but the rollover is not tax free. A rollover to a Roth IRA, like a conversion from a traditional IRA, is a taxable distribution except to the extent it is allocable to after-tax contributions (8.21).
Direct Rollover From Employer Plan
If you choose to have your plan administrator make a direct rollover of an eligible rollover distribution to a traditional IRA or another eligible employer plan (7.7), you avoid tax on the payment and no tax will be withheld. If you are changing jobs and want a direct rollover to the plan of the new employer, make sure that the plan accepts rollovers; if it does not, choose a direct rollover to a traditional IRA.
When you select the direct rollover option, your plan administrator may transfer the funds directly by check or electronically to the new plan, or you may be given a check payable to the new plan that you must deliver to the new plan.
Planning Reminder
In choosing a direct rollover to a traditional IRA, the terms of the plan making the payment will determine whether you may divide the distribution among several IRAs or whether you will be restricted to one IRA. For example, if you are entitled to receive a lump-sum distribution from your employer’s plan, you may want to split up your distribution into several traditional IRAs, but the employer may force you to select only one. After the direct rollover is made, you may then diversify your holdings by making tax-free trustee-to-trustee transfers to other traditional IRAs.
You may elect to make a direct rollover of part of your distribution and to receive the balance. The portion paid to you will be subject to 20% withholding and is not eligible for special averaging. Withholding is generally not required on distributions of less than $200.
A direct rollover will be reported by the payer plan to the IRS and to you on Form 1099-R, although the transfer is not taxable. The direct rollover will be reported in Box 1 of Form 1099-R, but zero will be entered as the taxable amount in Box 2a. In Box 7, Code G should be entered.
Personal Rollover After Receiving a Distribution
If you do not tell your plan administrator to make a direct rollover of an eligible rollover distribution, and you instead receive the distribution yourself, you will receive only 80% of the taxable portion (generally the entire distribution unless you made after-tax contributions); 20% will be withheld. Withholding does not apply to the portion of the distribution consisting of net unrealized appreciation from employer securities that is tax-free (7.10).
Planning Reminder
Although you receive only 80% of the taxable eligible rollover distribution, the full amount before withholding will be reported as the gross distribution in Box 1 of Form 1099-R. To avoid tax you must roll over the full amount within 60 days to a traditional IRA or another eligible employer plan. However, to roll over 100% of the distribution you will have to use other funds to replace the 20% withheld. If you roll over only the 80% received, the 20% balance will be taxable; see the John Anderson Example below. For the taxable part that is not rolled over, you may not use special averaging or capital gain treatment even if you meet the age test (7.4). In addition, if the distribution was made to you before you reached age 59½, the taxable amount will be subject to a 10% penalty unless you are disabled, separating from service after reaching age 55, or have substantial medical expenses; see the full list of exceptions below (7.15).
If a distribution includes your voluntary after-tax contributions to the qualified plan, they are tax free to you if you keep them. However, after-tax contributions may be rolled over to a qualified plan or a 403(b) plan that separately accounts for the after-tax amounts.
A rollover may include salary deferral contributions that were excludable from income when made, such as qualifying deferrals to a 401(k) plan. The rollover may also include accumulated deductible employee contributions (and allocable income) made after 1981 and before 1987. A qualified retirement plan may invest in a limited amount of life insurance which is then distributed to you as part of a lump-sum retirement distribution. You may be able to roll over the life insurance contract to the qualified plan of a new employer, but not to a traditional IRA. The law bars investment of IRA funds in life insurance contracts.
You may not claim a deduction for your rollover.
Multiple rollover accounts allowed.
You may wish to diversify a distribution in different investments. There is no limit on the number of rollover accounts you may have. A lump-sum distribution from a qualified plan may be rolled over to several traditional IRAs.
Caution
Reporting a personal rollover on your return.
When you receive a distribution that could have been rolled over, the payer will report on Form 1099-R the full taxable amount before withholding, although 20% has been withheld. However, if you make a rollover yourself within the 60-day period, the rollover reduces the taxable amount on your tax return. For example, if in 2012 you were entitled to a $100,000 lump-sum distribution and received $80,000 after mandatory 20% withholding and then you rolled over the full $100,000 into a traditional IRA, report $100,000 on Line 16a (pensions and annuities) of Form 1040 or Line 12a of Form 1040A, but enter zero as the taxable amount on Line 16b or Line 12b and write “Rollover” next to the line. If you roll over only part of the distribution, the amount of the lump sum not rolled over is entered as the taxable amount. Remember to include the 20% withholding on the line for federal income tax withheld.
IRS may waive 60-day deadline for personal rollover on equitable grounds.
Generally, a personal rollover must be completed by the 60th day following the day on which you receive a distribution from the qualified plan. However, the IRS has discretion to waive the 60-day deadline and permit more time for a rollover where failure to complete a timely rollover was due to events beyond your reasonable control, and failure to waive the deadline would be “against equity or good conscience.”
The same waiver rule applies to rollovers from traditional IRAs. See the IRS guidelines on granting a waiver (8.10).
Extension of 60-day rollover period for frozen deposits.
If you receive a qualifying distribution from a retirement plan and deposit the funds in a financial institution that becomes bankrupt or insolvent, you may be prevented from withdrawing the funds in time to complete a rollover within 60 days. If this happens, the 60-day period is extended while your account is “frozen.” The 60-day rollover period does not include days on which your account is frozen. Further, you have a minimum of 10 days after the release of the funds to complete the rollover.
Rollover by Beneficiary
Surviving spouse.
If you are your deceased spouse’s beneficiary, you may roll over your interest in his or her qualified plan account. You may choose to have the plan make a direct rollover to your own traditional IRA. The advantage of choosing the direct rollover is to avoid a 20% withholding. If the distribution is paid to you, 20% will be withheld. You may make a rollover within 60 days, but to completely avoid tax, you must include in the rollover the withheld amount, as illustrated in the John Anderson Example above. If you receive the distribution but do not make the rollover, you will be taxed on the distribution, but if your spouse was born before January 2, 1936, you may be able to use special averaging (7.4) to compute the tax. You are not subject to the 10% penalty for early distributions (7.15) even if you are under age 59½.
You can roll over the distribution to a Roth IRA but the rollover is taxable under the rules for conversions from traditional IRAs (8.21).
You may also roll over a distribution from your deceased spouse’s account to your own qualified plan, 403(a) qualified annuity, 403(b) tax-sheltered annuity, or governmental section 457 plan. However, if you were born before January 2, 1936, and want to preserve the option of electing averaging (7.4) or capital gain treatment (for pre-1974 participation, see 7.5) for a later distribution from your employer’s qualified plan, you should not roll over your deceased spouse’s account to your employer’s qualified plan. If the rollover is made to your employer’s qualified plan, a lump-sum distribution from the plan will not be eligible for averaging or capital gains treatment.
Rollover of distribution received under a divorce or support proceeding.
Law Alert
In a qualified domestic relations order (QDRO) meeting special tax law tests, a state court may give you the right to receive all or part of your spouse’s or former spouse’s retirement benefits. If you are entitled to receive an eligible rollover distribution (7.7), you can choose to have the distribution paid to you or you can instruct the plan to make a direct rollover to a traditional IRA or to your employer’s qualified plan if it accepts rollovers. Alternatively, if the distribution is paid to you, 20% withholding will apply. You may complete a rollover within 60 days under the rules for personal rollovers discussed earlier. If you do not make the rollover, the distribution you receive is taxable, but you may be able to elect special averaging if averaging would have been allowed had it been received by your spouse or former spouse (7.3). If only part of the distribution is rolled over, the balance is taxed as ordinary income in the year of receipt. In figuring your tax, you are allowed a prorated share of your former spouse’s cost investment, if any. You are not subject to the 10% penalty for early distributions even if under age 59½.
Nonspouse beneficiaries.
If you are entitled as a nonspouse beneficiary to receive a distribution from a qualified plan, 403(b) plan, or governmental 457 plan, the plan must allow you to roll it over to an IRA in a trustee-to-trustee transfer. The IRA must be treated as an inherited IRA subject to the required minimum distribution (RMD) rules for nonspouse beneficiaries (8.14). This means that you will have to begin receiving RMDs from the inherited IRA by the end of the year following the year of the plan participant’s death (8.14).